China Stimulus Should Have Positive Impact on EMs
China too should have a positive impact on EMs as a whole thanks to its fiscal stimulus. Typically EPS upgrades lag this kind of stimulus by six to 12 months. Recent economic data from China (industrial production up 6.5% vs. 5.6% expected, Q1 GDP at 6.4% vs. 6.3% expected)3 suggests the stimulus is already having a positive impact on growth and there should be more to come. Our economists continue to forecast 6.2% growth in China in 2019, as they did at the start of this year, despite trade risks. This means that the growth differential between EMs and DMs is likely to widen; typically, this is a strong positive for EM equities and debt.
At the macro level, the US dollar is looking expensive on most of our metrics, and cyclical indicators (oil, industrial growth, dovish central banks) all look much better than they did at the beginning of the year. This indicates that there should be room for P/E multiples to expand, as long as some accommodation is reached on trade in the next few months. Finally, the ongoing inclusion of China A securities in the MSCI EM index (with a weighting of around 3.4% by the end of 2019) should provide further support for EM assets. Analysts expect US$69 billion of flows into China as a result of this expanded inclusion. (For a closer look at emerging markets, see Emerging-Market Giants Drive Growth Despite Trade Risk.)
Concerns about Europe Keep Us on the Side Lines for Now
Despite European valuations appearing attractive relative to the US and elsewhere, political instability persists, not least uncertainty over the exact shape of Brexit, which will now not be known until October, and the increased presence of populist parties in the European Parliament. A sharp drop in economic growth (our economics team has cut its forecast for Europe’s GDP growth by 0.6% for 2019) and concerns about financial-sector equities keep us on the side lines for now.
While investors have become more optimistic about European equity markets on the back of the longer extension of the Brexit deadline, further dovish sentiment from the European Central Bank and the likelihood of better growth in EMs (which may feed through to better European equity market performance), we believe there is insufficient compensation offered relative to the US to justify a market weight position in the region. Some indicators like GBPUSD and EURUSD risk reversals4 (both trading at 2017 levels) seem too optimistic in relation to the potential resolution of political uncertainty, given the longstanding structural imbalances that persist in the eurozone.